Amazon: What Wall Street Still Gets Wrong

When it comes to expectations for Amazon.com’s profits, Wall Street is starting to come down from the clouds.

Shares of the e-commerce giant have fallen more than 16% since the beginning of 2016 as analysts have lowered their estimates for its future earnings. In December, analyst consensus estimates showed Amazon posting 2016 operating income of $4.5 billion. That estimate has since fallen to slightly less than $4 billion. Estimates for 2017 and 2018 have similarly declined. A major factor in those now lowered expectations: increasing competition for its Amazon Web Services cloud business.

The rapid growth of the high-margin AWS business has driven the bulk of Amazon’s recent profits. Operating income reached $2.2 billion in 2015, up from just $178 million in 2014. But given the presence of well-financed competitors such as Google and Microsoftin cloud services, investors should have known not to take AWS’s growing profitability for granted.

This is especially true in light of Amazon’s history of cutting prices to drive market-share expansion. Margins for AWS fell as low as 8% during the third quarter of 2014, versus 29% in the most recent quarter, after a big round of price cuts.

Heard on the Street pointed out in December that estimates for Amazon’s profits looked unrealistically high. Yet Wall Street seems to have gotten a bit ahead of itself. At least two research firms lowered their price targets this week, citing expected increasing competition for AWS. Google was also hosting a cloud conference this week, and some analysts are now saying that price cuts may lie ahead.

ENLARGE

If that comes to pass, this could put pressure on Amazon to cut prices again or ramp up its cloud investment. Recent high-profile wins for the search giant’s cloud business, including its new deal with longtime AWS customer Spotify, announced last month, could also presage future defections.

Of course, AWS isn’t the only reason that analysts have cited for their lowered numbers. Higher-than-expected shipping costs and greater-than-expected demand for fulfillment services from third-party sellers have also pressured gross margins. But the retail business was never expected to be Amazon’s major profit center—at least not until it flips the mythical switch turning off continuous investment in favor of profitability. Chances are, then, that estimates have further to fall.

For investors, Amazon’s golden age of profitability may remain just beyond the horizon.

http://www.wsj.com/articles/amazon-what-wall-street-still-gets-wrong-1458914693